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Market Bulletin - Last straw

29 May 2018

Growth in the UK came in at a five-year low, as US–China trade uncertainties persisted, and Italy’s new prime minister failed to calm markets.

Warren Buffett may be the third-wealthiest man on earth, but every morning he drops by a McDonald’s Drive-Thru to buy his breakfast. Before leaving home, the veteran investor asks his wife to drop his exact breakfast money into his car’s cup holder. If he’s feeling a little less prosperous than usual, he asks for $2.61 (the price of two Sausage Patties); if it’s broader markets that are struggling, he asks for $2.95 (for a Sausage McMuffin); only if the market’s up will he treat himself to a Bacon, Egg & Cheese Biscuit (as it’s called in the US) at $3.17.

In short, the ‘Sage of Omaha’ starts the day as prudently as he means to go on. For decades, Buffett has engaged in value investing, which he describes as “finding wonderful companies at fair prices”. It hasn’t gone badly: Buffett is the only person to have built a top-ten Fortune 500 company from scratch. As it happens, he no longer holds McDonald’s, meaning he had no say when shareholders voted last week against a proposal to review the company’s plastic straw policy for environmental reasons (not that his breakfast budget stretches to a McDonald’s drink). Yet he has surely shown that, by sticking with the tried-and-tested methods of value investing, even the best-known stocks can prove to be profitable investments.

Take Apple, the world’s largest company by market capitalisation. Buffett first bought into the company in early 2016, since when the share price has gained almost 80%. Earlier this month he bought a further 75 million shares in the company, making him Apple’s third-largest investor – it was already his largest position. Apple itself recently reported a first-quarter sales rise of 31%. It is not alone among tech majors in enjoying a bumper year; Amazon, the third-largest listing worldwide, it has grown in value more than any other company since Donald Trump took office, increasing its market value by $380 billion (in other words, its value has doubled).

The sector’s PR shine hasn’t been quite as strong this year. The Facebook data scandal rumbled on last week, as CEO Mark Zuckerberg appeared before a committee at the European Parliament to answer questions about the data breach. He has been widely criticised for failing to answer the questions put to him.

“Facebook still offers good value in terms of price,” says Hamish Douglass of Magellan Asset Management, manager of the St. James’s Place International Equity fund. “The base case for a fine [for the data breach] is $1 billion, which is pretty inconsequential for a $500 billion company. The only real risk is regulatory changes upsetting the business model.” Even on those, Douglass believes the likelihood remains relatively low. Indeed, Facebook’s share price rose over the course of last week. Only a decade ago, investors were asking whether it would ever turn a profit (it duly obliged in 2009); Facebook is now the fourth-largest listing on the S&P 500.

Google’s parent Alphabet, another S&P 500 top-ten stock, unveiled a revamped version of its YouTube subscription service to renew its assault on the music streaming dominance of Apple and Spotify. Morgan Stanley has forecast that the new service will have 25 million paid subscribers by 2022. Meanwhile, Japan’s Sony on Tuesday announced its purchase of a $2.3 billion controlling stake in EMI, founded in the UK in 1931, in order to extend its catalogue.

Over a barrel

Today, technology companies make up six of the ten largest listings on the S&P 500 – Buffett’s Berkshire Hathaway is one of the others. There is no doubting which sector they’ve forced out; back in 1980, six of the top ten were oil majors, against just one today. Yet last week, short-term trends buoyed the energy sector, as the price of a barrel of oil hovered around $75–80. The price rise may be recent, but some of its implications are already apparent, while others have been priced in. The oil majors are currently enjoying their strongest performance in a decade, and several are launching share buyback programmes while times are good, including Shell, BP and Total – BP announced its first dividend increase since 2014. (The price boost wasn’t enough to leave major indices up for the week – the FTSE 100 and TOPIX both ended significantly down; the S&P 500 finished almost flat.)

Yet some of the price rises are due to supply constraints caused by deteriorating political situations, such as economic collapse in Venezuela, the US pulling out the Iran deal and, as of last week, several successive days of nationwide strikes in Brazil. Petrobras, the country’s largest oil producer, lost almost 6% of its market value in a single day. Increased tensions in the Middle East more broadly are also reckoned to be a contributing factor. Amid these political headwinds, there were signs of the US and China potentially coming to new terms over trade. Steve Mnuchin, the US Treasury secretary, even announced that “we’re putting the trade war on hold”. In a similar vein, recent brinkmanship over North Korea subsided as Donald Trump said he still wanted to meet Kim Jong-Un.

A rising oil price has its losers too, however. Last week, Ryanair forecast a tougher year in 2019, for which it blamed Brexit, fuel prices and staff costs. Of course, consumers will suffer too, as pump prices rise. Nevertheless, inflation last week dipped slightly to 2.4%, despite improving retail news, pushing sterling to its lowest level for the year. That leaves it close to the Bank of England’s target, making imminent rate rises less likely. A broader worry came in the form of UK growth data for the first quarter, which was confirmed at a five-year low on declining business investment. Meanwhile, the head of HMRC warned that, in its current incarnation, Brexit will cost UK companies £17–20 billion a year in customs costs – if the ‘max fac’ option becomes a reality. Michel Barnier warned at the weekend that talks needed to “speed up” for a deal to be made.

Not that all remaining EU countries were humming to Brussels’ tune last week: Italy’s president confirmed the appointment of a Eurosceptic economist as the new prime minister – only to then reject the Eurosceptic nominee for finance minister. He subsequently appointed Carlo Cottarelli to head up a technocrat government, but Cottarelli is expected to lose a vote of confidence, forcing a fresh round of elections. The yield on 10-year Italian government debt began last week below 2%; at time of writing, it is above 3%. (Yields move inversely to prices.)

Stocks on the Milan bourse fell, as did the broader MSCI Europe ex UK, a trend that continued in early trading after the weekend– talk of Spain’s prime minister facing a no-confidence vote over party corruption added to fears. The European Central Bank, meanwhile, showed a talent for stating the obvious when it warned the more heavily indebted eurozone states that loosening their fiscal policy could cause investors to offload their bonds.

Trust the robots?

Amid all the evidence of technology’s advance on markets last week, the FCA sounded a note of warning over the use of technology to advise people on their financial planning. Its review of robo-advice identified shortcomings around both suitability and disclosure, which meant “significant changes” would need to be made. Meanwhile, a report published last week by Zurich found that 79% of retirees using pension freedoms to manage their retirement savings risk a “later-life financial crisis” since they have failed to set up a lasting power of attorney. When it comes to retirement planning, a lack of good advice can prove costly.

Magellan is a fund manager for St. James’s Place.

The information contained is correct as at the date of the article. The information contained does not constitute investment advice and is not intended to state, indicate or imply that current or past results are indicative of future results or expectations. Where the opinions of third parties are offered, these may not necessarily reflect those of St. James’s Place.

Source: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, endorsed, reviewed or produced by MSCI. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.

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